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What Is A Credit Default Swap (CDS)?

A Credit Default Swap (CDS) is a financial instrument that is effectively insurance on a bond. The idea behind them is that the owner of a CDS pays a certain amount per year (interest rate basis points) and if the asset that is backed by the CDS defaults, the CDS owner is paid off.

A bond is valued at 100 (par) and the CDS will pay the difference between the market value of the bond and par at the time of default, i.e. if bondholders receive 20 cents on the dollar the CDS will pay 80 cents per dollar.

Originally they were used as an insurance or hedging policy, but due to the fact that you do not have to own the asset in order to buy a default swap on it, they have become tools for relatively cheap speculation.

For example, if an investor believes that a corporation is going to default on its debts, they could buy credit default swaps from an investment bank. The investment bank would charge a certain amount per year in order to offer the insurance. If the investor bought swaps on $10 million worth of corporate bonds and the investment bank charged 250 basis points for 3 years, the investor would have a maximum risk of $750,000 (2.5% x $10,000,000 x 3) for a maximum gain of $10 million.

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Could a knowledgeable individual please explain Credit Default Swaps on a broad level? I'm a bit confused about who sold them, how they work, who gets paid in the event of bankruptcy, and what exactly happened with all the CDSs that Lehman I guess created and sold? Thanks.

I am looking for either Credit Default Swap Traders or Corporate Bond Traders, Junior Traders as well in these 2 categories. I need some advice, Please send me a message in my inbox, It would be greatly Appreciated!

Hi, I have been struggling to find information relating the credit default swap market of emerging country debt. I would appreciate it if any experts could provide me with some information or direct me to journals or papers written on this issue. It appears that there is little information on...

Hi, I have been struggling to find information relating the credit default swap market of emerging country debt. I would appreciate it if any experts could provide me with some information or direct me to journals or papers they or others have written on this issue. It appears that there is...

Hello I'm an undergraduate student at Eastern Michigan University and I'm taking an English course where I must write an essay on credit default swaps. The first requirement for this essay is to conduct a small interview with someone who has extensive knowledge on credit default swaps....

Don't Miss This Awesome Related WSO Content

Could a knowledgeable individual please explain Credit Default Swaps on a broad level? I'm a bit confused about who sold them, how they work, who gets paid in the event of bankruptcy, and what exactly happened with all the CDSs that Lehman I guess created and sold? Thanks.

I am looking for either Credit Default Swap Traders or Corporate Bond Traders, Junior Traders as well in these 2 categories. I need some advice, Please send me a message in my inbox, It would be greatly Appreciated!

Hi, I have been struggling to find information relating the credit default swap market of emerging country debt. I would appreciate it if any experts could provide me with some information or direct me to journals or papers written on this issue. It appears that there is little information on...

Hi, I have been struggling to find information relating the credit default swap market of emerging country debt. I would appreciate it if any experts could provide me with some information or direct me to journals or papers they or others have written on this issue. It appears that there is...

Hello I'm an undergraduate student at Eastern Michigan University and I'm taking an English course where I must write an essay on credit default swaps. The first requirement for this essay is to conduct a small interview with someone who has extensive knowledge on credit default swaps....

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